As China continues work on containing the spread of the coronavirus and many factories are doing last minute checks this week in hopes of being able to open on Saturday, Wall Street is concerned that additional delays will impact the global supply chain and leave retailers short on inventory to stock their shelves.
Fashion firms that have been reporting earnings have detailed the impact from the health crisis for the next reporting period. Others, such as Kering Group, are moving to a backup plan to minimize the impact on profits and control inventory distribution. In general, there’s still a lot of uncertainty over what course the virus will take and how much longer it will linger. That will impact how quickly factories can ramp up production and play catch up once they reopen their doors.
Ralph Lauren Corp.
On Thursday, Ralph Lauren Corp. updated fourth quarter guidance. The company reported third quarter earnings at the start of this month, but at that time the health crisis was still in the early stages and companies were still awaiting further instructions from the Chinese government on containment. The company is now estimating a negative impact of $55 million to $70 million in sales and $35 million to $45 million in operating income in Asia, driven by current trends in China, Japan and Korea. In addition, two-thirds of the company’s stores in Mainland China have been temporarily closed over the past week, and the company said it “expects broader impact across its businesses in China and part of Asia due to significantly reduced travel and retail traffic.”
“These estimates could materially change if there is meaningful deterioration from current trends. Supply chain disruptions in China could also impact a small portion of the company’s fourth quarter orders globally,” the company said, adding that it plans to provide an updated on operational and financial impact along with Fiscal 2021 and first quarter guidance when the company reports fourth quarter Fiscal 2020 results.
“Our dedicated teams are operating with agility in a highly dynamic situation, and we will continue to assess the implications for our business across retail, corporate and our supply base,” Patrice Louvet, president and CEO, said.
Supply chain risks
Wells Fargo analyst Ike Boruchow sounded the supply chain alarm earlier this week, noting that channel checks suggest the risk of a broader supply disruption is rising rapidly for U.S. retailers. “The next few weeks should be critical, as further delays in the restart of production could begin to result in out-of-stocks at U.S. shelves as early as mid-April,” he projected.
In the specialty softlines space, there is a “wide range of sourcing exposures to China,” Boruchow said.
Big-box retailers such as Target and Walmart “could be the first to experience out of stock issues, as they are more heavily dependent on a short lead time replenishment model,” Wells Fargo senior analyst Edward J. Kelley.
“Our industry contacts indicate that these companies likely have 60-plus days of replenishment inventory in the U.S. at the moment,” he added. “We would also highlight that no one is completely immune, as even staples players like Costco, BJ’s and Kroger could see some impact, given China’s role in packaging materials and other commodity items like basic paper products.”
Below Five, Dollar Tree and Dollarama could also see shortages.
Information coming out of China remains limited and nearly 60 million people are still in lockdown mode, under travel restrictions imposed in 15 cities across the central Chinese province of Hubei. The rest of the country has also seen dramatic reductions in activity. Even when many companies reopened their doors this past Monday, many employees worked from home.
On the factory front, many this week began opening their doors not to restart production but to check equipment and complete sanitization measures before they let employees enter on Saturday if they are able to restart operations. Presuming factories can open, there are other questions at play, such as how many of their employees–either because of travel or quarantine periods–will be able to return to work, and whether it has enough components in stock to finish work orders. And even if some orders can be completed, there’s then the question of whether those goods can be shipped out, given some of the travel restrictions that are in place.
For now, the expectation is that many companies still have higher inventory levels than usual, mostly due to an intentional build up because of tariffs and trade war uncertainty at the start of 2020. That’s because even though there was a Phase One agreement between the U.S. and China, no one was certain on when it would be signed. While the intent was to bring in goods ahead of the planned tariff increases, elevated inventory levels now will help retailers withstand some short-term interruptions, Mark Vitner, Wells Fargo’s senior economist, said during a conference call.
The economist believes that the computer and electronic supply chains will be most impacted, along with industrial machinery, since many of the parts needed for manufacture are from China. He also noted the impact on attendance at trade shows, such as the Materials Show for textiles that was slated to take place this week in Portland, Ore., which have had a growing dependence on Chinese suppliers. The cancellation of the textiles show also could carry through to future orders, since companies rely on the shows to see what’s new before committing to design and production of new product lines, Vitner explained.
There also could be a corresponding impact on port traffic. Ports have become major economic drivers because they support transportation, logistics and distribution jobs, Vitner said. The ports of Los Angeles-Long Beach, Oakland, Seattle/Tacoma and Portland on the West Coast handle a “massive amount of trade with China,” he said, adding that the ports on the Eastern seaboard also are exposed, mostly due to rising capacity as more shipments head directly to the East via the Panama Canal expansion.
Coronavirus and China Impact
The flu-like virus was believed to have killed more than 1,100 people and sickened over 45,000. Over the past weekend, it appeared that new cases were starting to level off in Wuhan, the epicenter of the outbreak but a new diagnostic technique has sparked a sharp uptick in f cases.
“CT scans have been in use in Hubei for at least the last week as a faster, more readily available, and possibly more accurate method of testing…. The change significantly hurts confidence in the official China disclosures,” Kevin Kopelman, managing director and hotel and travel analyst at Cowen & Co., said.
Officials in Beijing on Thursday expanded their mass roundup of people sick or possibly infected beyond Wuhan to include other cities in Hubei Province, a New York Times report said.
The Chinese economy is expected to slow significantly in 2020, particularly in the first quarter. Wells Fargo’s macro strategist Brendan McKenna lowered China’s growth forecast to 5.5 percent from 5.9 percent, while his first quarter projection is 5.1 percent, down from the previous expectation of 5.9 percent.
“The full effects of the outbreak on economic activity will not be known for some time,” McKenna said, noting that the compilation of statistics data from China and the annual shift in timing of the Lunar New Year clouds the reading.
He also expects the impact from the virus to have some spillover effect on its neighbors. “Macau is the top gambling destination, McKenna said. “The casinos have been closed for a few weeks. Thailand and Indonesia see travel [tourism] from China, and now [see a] dent.”
And because of trade dependencies, nearby Taiwan and Hong Kong will be impacted, as well as Australia and even further away, Chile and Brazil, McKenna said.